Buying income shares is one way I aim to boost my passive income streams, thanks to the dividend potential they offer.
If I had a spare £5,000 to invest right now and wanted to target annual dividend income of £300, here is how I would go about it.
Income — and sources of income
One common mistake investors make when it comes to income shares is immediately zooming in on their dividend yield without considering the source of dividends.
But dividends are basically drawn from the income a company makes – in other words, its profits after the business has paid its costs.
So when looking for shares to buy with an eye on their dividend potential, I first look at what I think the company’s income prospects are like.
Assessing a dividend share
As an example, consider meat producer Cranswick. It has a proven track record of growing sales and profits that I think could continue. That could help it fund dividend growth. It has grown its dividend annually for over three decades.
So I think Cranswick is an attractive company in terms of its income potential. But will it be lucrative enough to help me hit my target? After all, the dividend yield is only 2.8%.
To reduce my risk, I would spread the investment of £5,000 across a variety of shares. I would need an average yield of 6% to hit my £300 annual target. Cranswick’s yield is below that. But that might be okay, as I could buy shares with yields lower or higher than 6% as long as the average yield for my £5,000 was 6% or more.
Choosing income shares to buy
Right now, though, there are companies I like as much as Cranswick for their income prospects but with higher yields. So I would not currently buy Cranswick for my portfolio if my only objective was income.
Instead I have been buying shares like Dunelm, with a 5% yield even excluding special dividends the retailer has paid in recent years. Like Cranswick, it has an impressive record of revenue growth that I hope can continue. Consumers reducing their spending could lead to sales falling. But Dunelm has a strong market position and established customer base. I am hopeful it could pay me chunky dividends for years to come.
Spreading my risks
With £5,000 to invest, I could buy £1,000 worth of shares in a handful of different companies such as Dunelm.
Right now, I think a lot of income shares are attractively valued after price falls. Dunelm, for example, has seen its share price decline 39% in the past year.
But if I could not find five income shares I wanted to buy right now, I would take my time and invest the full £5,000 only once I found what I thought were quality companies selling at attractive prices. That might mean it took me longer to hit my annual dividend target of £300. But remember, I am focussed on quality shares I think have strong future dividend potential — not just chasing yield.